What is Dividend
A dividend is the distribution of profits a company earns to its shareholders. In other words, companies reward their investors with dividends for investing their money in the company. Shareholders who invest money in a company seek a return on investment in two ways.
1. Firstly, through dividends and
2. Secondly, through capital appreciation.You may receive dividend income if you have invested in shares, have a family or owner-managed company, and extract profits from dividends. Dividends are treated as the top slice of income. Consequently, the rate you pay tax on your dividend income depends on your other taxable income in the year and whether you have used up your personal allowance and dividend allowance.
Dividend allowance
Dividends have their own tax-free allowance – the dividend allowance. It is available in addition to the personal allowance. All taxpayers are entitled to a dividend allowance of £2,000 for 2022/23, regardless of the rate at which they pay tax. Although termed the ‘dividend allowance’, it is actually a zero-rate band rather than an allowance, with dividends sheltered by the allowance being taxed at a zero rate.
Dividend tax rates
There are three dividend tax rates:
Dividends are not liable for National Insurance contributions (NICs), so where profits in a family or personal company are extracted predominantly in the form of dividends, there will be no NICs to pay. Examples to understand the tax on dividends:
Example 1: No tax to pay
Milly is a student. She earns £3,000 in 2022/23 from part-time work. She also holds shares in her family’s company, in respect of which she receives a dividend of £5,000. Milly’s total income for 2022/23 is less than her personal allowance of £12,570, so she has no tax to pay on her dividend income of £5,000.
Example 2: Covered by allowances
Ben receives a salary of £11,000. He also has a small personal company and can pay himself a dividend of £3,500 for 2022/23. Ben’s salary uses up £11,000 of his personal allowance for 2022/23 of £12,570, leaving £1,570 available. This is set against his dividend, reducing it to £1,930. This is covered by the dividend allowance of £2,000, meaning Ben has no tax to pay on his dividend of £3,500 as it is fully sheltered by his remaining personal allowance and the dividend allowance.
Example 3: Basic rate taxpayer
Norman has a pension of £20,000 and a share portfolio from which he receives dividends of £15,000 in 2022/23. Norman’s salary uses up his personal allowance (£12,570) and the first £7,430 of his basic rate band, leaving £30,270 of his basic rate band available (£37,700 – £7,430).
The first £2,000 of his dividends are tax-free sheltered by the dividend allowance. However, the dividend allowance uses up £2,000 of his basic rate band leaving £28,270 available. The remaining dividends of £13,000 fall wholly within the basic rate band and are taxed at the dividend ordinary rate, which for 2022/23 is 8.75%. Consequently, Norman must pay tax of £1,137.50 (£13,000 @ 8.75%) on his dividends.
It can be understood better with the help of the table given below.
Example 4: Partly taxable at dividend higher rate
Bella has a salary of £47,000 for 2022/23. She also receives dividends of £10,000 from her family company. Her salary uses up her personal allowance of £12,570 and £34,430 of her basic rate band, leaving £3,270 of her basic rate band available (£37,700 – £30,430).
The first £2,000 of her dividends are tax-free, sheltered by the dividend allowance. The dividend allowance uses up a further £2,000 of her basic rate band, leaving £1,270 available.
Of the remaining dividends of £8,000 not covered by the dividend allowance, the first £1,270 falls within the basic rate band and is taxed at the dividend ordinary rate of 8.75%. The balance of £6,730 falls within the higher rate band and is taxed at the dividend upper rate of 33.75%.
Consequently, Bella pays tax of £2,382.50 ((£1,270 @ 8.75%) + (£6,730 @ 33.75%)) on her dividends of £10,000.
Example 5: Taxed at dividend additional rate
Jacob has a salary of £120,000 and income from property of £60,000 in 2022/23. He also receives dividends of £30,000 from his family company and further dividends of £20,000 from his share portfolio. His total dividend income for 2022/23 is £50,000. He has other income of £180,000. Consequently, his dividend income, treated as the top slice, falls in the additional rate band.
The dividend allowance sheltered the first £2,000 of his dividend income. The remaining £48,000 is taxed at the additional dividend rate of 39.35%. Consequently, he pays a tax of £18,888 on his 2022/23 dividends of £50,000.
Do not hesitate to contact us if you need help understanding dividend taxes.